Thursday, 27 May 2010

In the last few years, several of our governments have made a strong commitment to invest in education, in order to improve the economy’s human capital and competitiveness. And commitment there was. After decades of underinvestment in its human capital, Portugal now spends more in Education in percentage of GDP than the average country in the OECD. The big question is thus: how efficient this investment in Education has been to raise both the quality and quantity of human capital? And the sad answer is: not much.

How do we know that? Well, we just have to look at the results of the PISA surveys to know that the quality of education in Portugal is still somewhat lacking. Simply put, nobody in the OECD scores worse in terms quality of education (math, reading and science) than our students, with the dubious exception of Mexico and Turkey. Still, and knowing that the PISA methodology is not perfect, do we have any other evidence with regards to the efficiency of our educational system? The answer is positive. Luckily, the new Barro-Lee dataset has just been published and the results are simply very telling.

There are good news and bad news when we analyze the Barro-Lee data on average years of schooling.

The good news is that, indeed, and as we can see in graph 1, there has been a steady increase in the average years of schooling since the 1950s, and, more particularly, after the implementation of democracy.

Monday, 24 May 2010

Independently of whether we decide to impose constitutional requirements on the growth of public debt and the budget deficit (a good idea, which I have also defended here), I strongly believe that the next government would greatly benefit if it could achieve a balanced budget as rapidly as possible.

More specifically, I believe that a balanced budget could be achieved by 2016 without unacceptable sacrifices or social tensions and without a major recessionary impact. Why? Because, if all goes according to plan (a big if, I know), the budget deficit will be below 3% of GDP by 2013. Hence, the government would “only” need to reduce the deficit by 1 percentage point per year until a balanced budget is reached by 2016. A 1-percentage point per year reduction in the budget deficit does not strike me as recessionary, especially when compared with the targets of deficit abatement already set for 2010 and 2011.

The question is thus: Why should we aim for a balanced budget? Two words: credibility and reform. Let’s start with the former. One of the sad state of affairs of our economic policy is that most of our governments (not all, but most) have shown a total lack of respect by those who ultimately pay the bills: the taxpayers. By expanding public expenditures virtually without restrain, the Portuguese governments are constantly expecting not only that the subsequent rise in the tax burden will not harm the economy, but also that taxpayers will not mind paying the tab for the rise in expenses (obviously, the last few years have increasingly shown that these two premises are simply wrong).

Therefore, it is not totally surprising that, since democracy was implemented, no government was even close to achieving a balanced budget. Far from it. As we can see in the graph below, the Portuguese governments have always maintained significant budget deficits, even at times of fast economic growth, when revenues are higher.

Wednesday, 19 May 2010

Even before it began, Europe's moment as a major world power in the 21st century looks to be over. Richard Haass

The euro is in danger…If the euro fails, then Europe fails. If we succeed, Europe will be stronger. Angela Merkel

I think of the current state of the EMU as the result of three events. The first event is the political decision to adopt a common currency leaving EMU members without automatic mechanisms to adjust to external imbalances beyond self-equilibrating forces. The second event is the global financial crisis with her consequences including the recognition that large shocks are not an historical curiosity. The third event is the sudden comprehension by the financial markets of the first event.

The next figure partially summarizes the state of the EMU. The data are from the ECB and are used to set the stance of monetary policy.

Two sub-periods are evident: the pre-crisis and the post-crisis periods. The first 8 years show the performance of the ECB in controlling inflation ad stabilizing it around 2%: impressive. Equally impressing is the inflation oscillation that started in 2008 and is still unfolding. The EMU public debt to GDP ratio was stable at roughly 70% (10% more than the Maastricht rule) until the global financial crisis. The decline in output and the consequent worsening of public finances have now increased the debt to gdp ratio to almost 80%. Similarly the EMU public deficit has fluctuated around the -3% Maastricht limit until it ballooned during the crisis. Notably the EMU area has always had a fairly balanced current account and her actual net external position is small. The EMU growth has averaged 2.3% from 1999 to 2007 to later collapse and the EMU unemployment rate moved around 8.5%.

I see a picture of a sufficiently solid although static euro area that was hit by a large shock. There could be some concerns regarding the control of inflation (personally I am more worried by the downward trend of the inflation rate that excludes energy). The unemployment performance is unsatisfactory but this is not the picture of a collapsing economy. To observe the large imbalances that are threatening the euro we have to shift to a disaggregated picture.

The next figure depicts the state of the individual members of the EMU.

The heterogeneity within the euro is large in every dimension. Some states have very large debts, some have very large current account deficits, some have both and other have incredible unemployment rates for a modern democracy. The crisis has potentially put some of the weakest states in an unsustainable debt position exacerbated by large external imbalances. The heterogeneity per se is not a sufficient condition for questioning the existence of the euro area (and weights matter). For example the US states are very different in terms of employment, fiscal stance, size, productivity, ratings, etc (see here and here). The EMU has to design and adopt the minimum set of adjustment mechanisms that have to be present within a common currency area. There are many proposals that are discussed such as a common bond market and a larger fiscal integration. For the latter it could be interesting for europeans to know how much of the adjustment to the current shock is achieved in the US through automatic stabilizers such as unemployment benefits and how much is achieved through labor mobility (workers migration).

What is really necessary is for the EMU leaders to decide if they want to continue the integration of Europe (and how: a centralized state or the Europe of regions) or decide to go back to the now obsolete nation-state paradigm. A shadow is rising within Europe and it requires courage to dissipate it.

Tuesday, 18 May 2010

I found the latest post to this blogue, by Pedro Pita Barros, most interesting, and I dare to take on his challenge and "say something".
Let me begin with my aprioris.
1. I consider Luis Amado one of the most intelligent and well prepared Portuguese politicians -- in fact, one of the very few.
2. I think that the only way out for the Euro to go on is for the Area to embark on some sort of fiscal federalism.
Hence my interpretation: Luís Amado is setting the stage for such a reform, as well as the Portuguese committment to it: a European fiscal federalism that may be accepted by Germany and the other relevant countries in the Area; only with fiscal rules would the big European countries accept it.
The European history seems to suggest that the "democratic way" is a receipt for failure, as regards economic reforms. Thus, I think that the way things seem to be going is the right one: politicians should cook everything carefully and have the Parliaments approving fiscal federalism (the problem here are constitucional laws... ok, I'm doing some wishfull thinking here)
Finally, let me stress that fiscal rules are of the outmost convenience for Portugal and the likes. If only we've had fiscal discipline imported, in the past, as we have imported monetary discipline...

Yesterday, a surprising proposal was presented by Luis Amado, a member of the cabinet: set a constitutional limit to the public debt and to the public deficit.

Two issues deserve comment:

a) the idea itself

b) the moment it is presented

A final curiosity - being proposed by a current Minister, who does not hold an economic ministry!
About the idea, given the reputation of Southern countries spending too much, this could be a credible commitment if the mechanisms in action in case of non-compliance are clear, transparent and fair. What can they be? not sure, suggestions ?

About the moment, given the "troubled waters" with financing of public debt, I wonder how much this measure can make a difference. It only works for the long term, but that's probably better than just taking measures for the next two weeks.

Since the problem of the Portuguese economy has been pointed out to be one of sluggish growth, with Government presence in the economy being one of hindering factors, this measure may restore some confidence on better long term prospects for the economy.

On the other hand, it may be seen as only "lip service" to current difficulties, and be disregarded as irrelevant.

I lean to the side of considering it adequate, if political parties find a way to make it enforceable, as just writing it in the Constitution does provide much, even if in the short run it does not change much.

Against all odds, Paul Krugman wrote too many words: his argument in this post, which will certainly be quoted by many in Portugal, boils down to this: the euro is impossible. I hope that history will prove him wrong. How many in America bet, in 1948, that the ECSC and the EEC would work out? Are things different now? Yes and no - and the no bit is certainly more relevant.

Wednesday, 12 May 2010

Since the beginning of Spring 2010 Portugal's economic policy has effectively ceased to be independent. To put it more accuratelly, it has lost the relative autonomy it still had. For the time being, Brussels and the European Council will be ruling Portugal and Greece (maybe Spain should also be included). We are now travelling in uncharted waters. And we don't know how long the journey is going take.

"So why not also in Europe under the euro? As I see it, domestic German policies, perhaps aimed at absorbing East German unemployment, forced a structural trade surplus. The strong euro, along with the automatic recycling of Germany’s large trade surplus within Europe, ensured the corresponding trade deficits in the rest of Europe – unless Europeans were willing to enact policies that raised unemployment in order to counter the deficits. As long as the ECB refused to raise interest rates, southern Europe had to accept asset bubbles and rapidly rising debt-fueled consumption. // This couldn’t go on forever, or even for very long. Now southern Europe is paying the inevitable price, and of course the moralists are accusing the south of being shiftless and lazy, confusing the automatic balancing mechanisms in the balance of payments with moral weakness." Seehere

Thursday, 6 May 2010

A graph is worth a thousand words. Still I will give you a story. Portugal trade balance (TB) deficit has always been present (from 1985 to 2008 the average was -7.4% per year). It is intrinsically structural and has a large negative effect on the current account (CA). From 1985 to 1995 the surplus in invisible current transactions (including those without a quid pro quo) kept the CA balanced. The decrease in transfers and the expected participation into the EMU spurred an increase in consumption and investment worsening the CA. Today the CA deficit is larger in absolute value than the TB deficit. A dry story. Portugal must reverse the CA trend and the consequent deterioration in its external position. Within the EMU the old short run fix offered by a devaluation (it might have worked in the 80's but was massive) is not possible anymore. I wonder what part of the CA can be timely influenced by policy. Should short run rebalancing focus on the invisible transactions? The current transfers cannot be controlled (meaning they are at other's discretion). Can a better management of the external Investment have some effect? I suspect that long run rebalancing will only come with a transformation from a net importer into a net exporter (as it is suited to a small open economy). I might have an intuition on how to do it but I need to dig a little deeper into the details and anyway it is long run idea. Another graph.

Wednesday, 5 May 2010

Private debt in the Portuguese economy increased sharply after the mid-1990s – households and non-financial firms’ debts increased from 26% and 47% of GDP, in 1995, to 99% and 115%, in 2009, respectively. Lower inflation rates and interest rates (that followed the adhesion to the EMS and to the Euro), high GDP growth rates until 2000, development of the financial system and urbanization are among the main causes of that trend. Although consumption smoothing is the obvious explanation for households’ behaviour, the causes of the huge non-financial firms’ indebtedness is not so obvious (it does not show up in productivity statistics, for example). Public debt as a percentage of GDP was fairly stable in this period, despite the increasing weight of public expenditure in GDP. The increasing trend in private debt coincided with a decreasing trend in households’ savings. Greece, Spain and Ireland shared some of those trends and its corollary: significant current account deficits.

In the first years of the euro, there was a scholarly discussion on the implications of current account deficits in the context of the European Monetary Union. The position that prevailed in this debate was that external imbalances were benign and should not be the cause of concern: poorest countries were catching up and needed more investment (which was expected to get a higher return in these countries). This was also the conclusion of Olivier Blanchard and Francesco Giavazzi, in 2002, published in Brookings Papers in Economic Activity:

The fact that Portugal and Greece are members of both the European Union and the euro area, and the fact that they are the poorest members of both groups, suggest a natural explanation for today’s current account deficits. They are exactly what theory suggests can and should happen (…).(…) we discuss whether the current attitude of benign neglect vis-à-vis the current account in the euro area countries is appropriate, or whether countries such as Portugal and Greece should take measures to reduce their deficits. We conclude that, as a general rule, they should not.

The behaviour of interest rates suggests that, until the disruption of the international financial crisis, markets shared that view, that is, they seemed to have taken Germany and Portuguese debt as almost perfect substitutes.

The recent increase in the risk premium of Portuguese debt seems to be an adjustment to reality. We hope there is not too much overshooting in that process. And, of course, we should improve our reality.

Saturday, 1 May 2010

Pedro Passos Coelho, the new leader of the main opposition party, PSD, has called for a revision of the Portuguese constitutional law. Among other things, he wants to change the Portuguese electoral system.